Terra — An Emerging Ecosystem
By Remi Tetot
With thanks to James Wallace, Michael Hua and William Wilkens
Disclaimer: This article was written in October and originally published in Global Macro Investor (GMI) in November 2021 to introduce Terra’s ecosystem to institutional investors. This piece only reflects the author’s point of view. This article does not represent Raoul Pal or GMI point of view in any way.
Luna holds the largest position in my portfolio.
Following the article GMI published a couple of months ago about Solana, I began investigating Terra (Luna); Raoul’s point — that new chains may outperform in this bull run — really resonated with me.
We discovered that Solana’s price behaviour was very similar to that of Ethereum in 2017…
… and on comparing Luna with Ethereum, the similarities are obvious…
Between Polkadot, Avalanche and Terra, the latter seemed to offer the best risk reward opportunity because of a fast-growing network effect, so I decided to investigate fully, spending considerable time over the last few weeks talking with the various founders of important protocols being built on Terra.
First things first…
What is Terra money?
Binance summarised Terra perfectly:
“Terra is a blockchain network built using Cosmos SDK specializing in stablecoin creation. Rather than use fiat or over-collateralized crypto as reserves, each Terra stablecoin is convertible into the network’s native token, LUNA.
LUNA allows holders to pay network fees, participate in governance, stake in the Tendermint Delegated Proof of Stake consensus mechanism, and peg stablecoins.
To peg a stablecoin like TerraUSD (UST), a USD value of LUNA is convertible at a 1:1 ratio with UST tokens. If UST’s price is, for example, at $0.98, arbitrageurs swap 1 UST for $1 of USD and make 2 cents. This mechanism increases UST demand and also reduces its supply as the UST is burned. The stablecoin then returns to its peg.
When UST is above $1, say at $1.02, arbitrageurs convert $1 of LUNA into 1 UST and make 2 cents. The supply of UST increases, and demand for UST also decreases, bringing the price back to peg.
Apart from reducing stablecoin volatility, validators and delegators stake LUNA for rewards. These two actors play an essential part in keeping the network secure and confirming transactions.”
In a nutshell, the primary purpose of Terra is to create a decentralised stablecoin: UST. Luna is used as a tool to help maintain the peg by creating an arb opportunity.
How does the peg work?
The burning/minting mechanism enables arbitrage opportunities as changing demand for UST causes the price of UST in USD terms to rise or fall.
Let’s use an example to help wrap our heads around it:
1. Demand for UST increases, causing 1 UST to be worth more than $1 (let’s say $1.10).
2. Arbitrageurs that hold Luna can now swap $1 worth of Luna for 1 UST (by the mechanism mentioned above, minting 1 UST).
3. The 1 UST you have just minted can now be sold for $1.10.
4. Arbitrageurs have sold $1 worth of Luna and received $1.1.
5. The supply of UST has increased as it was minted during the swap, in theory causing the price of UST to fall back to its peg as more people arbitrage.
In stage 2 of this example, the Luna you swapped for UST is burned, decreasing the supply of Luna.
To simplify, the value of Luna is tied to the demand for UST. Increasing (decreasing) demand for UST will decrease (increase) the supply of Luna as arbitrage opportunities arise. As such, Luna is a form of “volatility absorber” that stabilises the price of UST.
“A decentralized economy needs a decentralized stablecoin” — Terra Founder, Do Kwon.
“Stablecoins facilitate 80% of crypto volumes but only represent 5% of crypto market cap, there is work that needs to be done” — SEC Chair, Gary Gensler.
By design, UST is programmed to become a much bigger stablecoin in the near future; it currently has a market cap of $2.7bn (fifth largest stablecoin) and is the only one truly decentralised (of the top five, DAI being a mix of other centralised stablecoins).
And although it is the fifth largest stablecoin, it has been growing at a much faster pace than any other stablecoin this year…
The constant FUD around USDT and USDC is a massive opportunity for Terra and UST.
Ok, it is a decentralised algo stablecoin, what is the big deal though?
The big deal is everything else that is being built on it and the number of cross-chain integrations.
But before diving in deeper here, let’s take a look at the core protocols enabling so many products to exist: Anchor and Mirror.
Anchor — money market
Anchor is Terra’s primary money market. Lenders are able to earn high and consistent yields on their $UST deposits due to specific protocol mechanisms. Borrowers who seek access to leverage can collateralise crypto-native assets such as $LUNA and $ETH in order to obtain stablecoins without sacrificing the opportunity cost from collateral gains. Over the past month, Anchor’s users have almost doubled…
Anchor’s current advertised deposit APY is 20%, which is exponentially higher than traditional banking account products, and up to 10x higher than blue-chip DeFi platforms such as AAVE and Compound. Anchor can pay its lenders such high rates partly because borrowers must forgo their collateral staking yields when a loan is initiated.
A borrower’s collateral (i.e., $LUNA or $ETH) yields are transferred to Anchor and eventually distributed to lenders. For $LUNA specifically, the yield earned on the borrower’s collateral has historically hovered close to 10% but in the past month has hovered in the 5% range. However, yield on Luna is expected to triple in the next couple of weeks (more about this later).
Yields are derived from pro-rated shares of network fees. Anchor can also sustain its 20% rate for the time being as the gross borrow rate is ~22% APY. Anchor’s total collateral is now over $3 billion…
These deposits should only increase as Terra increases its interoperability with other blockchains, especially with products like Orion giving Anchor yield exposure to ERC-20 stablecoins…
Realistically, a borrowing rate of 22% APY at greater than a 50% utilisation rate would not be as high if there were no $ANC subsidies, which are distributed to borrowers in order to encourage money market activity and to sustain lender yields.
These subsidies have a negative effect solely on the $ANC token, because many borrowers will simply spot sell $ANC on the market as soon as they collect the reward, and this creates tremendous downward pressure on the price of $ANC. However, the aggregate benefit to Terra is undoubtedly positive…
Borrower subsidies are used by protocol treasuries to offer additional incentives for user interaction. The goal of subsidies is to increase traction and awareness of the corresponding ecosystem and encourage capital to remain within the system in the long term. Ideally, a protocol like Anchor can decrease subsidies over time as network effects grow.
Mirror — permissionless synthetic asset platform
Mirror is a permissionless synthetic asset platform that offers composable on-chain equities. Users have the option of minting or shorting shares through a collateralised debt position, or providing liquidity to equity-stablecoin pairs to earn trading fees. Mirror has over $1.8 billion in funds locked in its protocol…
Mirror is extremely efficient as users can put up interest-bearing deposit tokens from Anchor as collateral to mint synthetic equities. Other forms of collateral include $LUNA as well as Mirror assets themselves. This way, a user can earn a stable 20% APY from Anchor while also gaining exposure to the potential upside in equities.
Moreover, the market cap of tokenised assets (mAssets) has reached over $450M…
Active users on the Mirror platform have also been increasing…
Once Mars Protocol is released (more about Mars later), Mirror assets can offer the same concept as traditional Lombard lending. Users will be able to collateralise their synthetic equities to borrow regular stablecoins, which can be used for everyday expenses without having to sell the potential upside in appreciating assets.
A fast-growing ecosystem
To understand what is about to happen to Luna and UST, we can look at how the roadmap is evolving. Here is a snapshot taken in July of protocols being developed on Terra…
And here is the updated snapshot from September; it doesn’t take much imagination to understand what the next snapshot will look like…
All these projects will either need UST or Luna in their ecosystems, which will not only be beneficial to Luna price action but will also increase UST growth.
Shortly after the Columbus-5 network upgrade, the first NFT projects were launched on Terra. The Metaverse/gaming/NFT space is also rapidly evolving…
… and some unique projects like Terra Whales are merging AR and NFT technology…
Terraform Labs and Delphi Labs are the two main incubators on Terra.
Delphi Digital saw the potential of Terra very early and has a dedicated team building and incubating projects on it (amongst other chains) — Delphi Labs. is incubating the most important aspects of the ecosystem: lending and DEX protocols (plus others) on Terra, Mars and Astroport…
I talked to Jose Maria Macedo, who runs Delphi Labs, as I was curious as to why they were focussing more resources on Terra than Solana.
One of the reasons was that development tools and SDK kits are designed better on Terra, making it easier to develop and more efficient. However, he was clearly bullish on both chains.
Of all the projects being launched within the next two months, five are stand-outs, have huge potential upside, and will become core protocols of the ecosystem…
Mars Protocol — Lending — Delphi Labs
Mars is dubbed the “Bank of the Future” and is a non-custodial open-source credit facility…
Users will be able to deposit assets to supply credit markets and earn interest. They will also be able to borrow against any asset and even take out undercollateralised loans.
One of the killer features of the Mars Protocol will be to lend/borrow against your LP tokens on Astroport, giving you the opportunity to compound yield and increase capital efficiency.
Astroport — Decentralised Exchange AMM — Delphi Labs / Terraform Labs / IDEO CoLab Ventures
Excerpt from the Astroport Litepaper:
“Astroport is the central space station of the Terra solar system, where travelers from all over the galaxy (Mirrans, Terrans, Anchorians, and more) meet to trustlessly exchange assets. As a galactic public good, Astroport will be governed by the Astral Assembly, a council of cryptonauts representing all corners of the universe.
The design philosophy behind Astroport is simple: to enable decentralised, non-custodial liquidity and price discovery for any asset. To achieve this, Astroport prioritises flexibility above all else; combining various specialised pool types and routing seamlessly across them.
Astroport empowers users to choose different pool types within a single AMM system. We believe this will enable Astroport to become the liquidity hub for the Terra DeFi ecosystem, with the built-in flexibility necessary to support all the asset types of Terra. It has permissionless asset listing, is community-governed and will launch with a non-exclusive, customised web interface we believe will provide best-in-class UI.”
Astroport will be to Terra what Uniswap is to Ethereum.
The derivatives opportunity
Centralised Finance (CeFi)
Currently in CeFi, exchanges like Binance, OKEx, and FTX, are doing anywhere from two to five times more in volume on the derivatives market than on the spot market…
Levana — Derivatives — Delphi Labs
With the name Levana being an acronym for “Leverage Any Asset”, it will serve to be the hub in the Terra ecosystem for anyone to create leveraged products. Being one of the few projects currently being incubated by Delphi Labs, it will work closely with Mars Protocol to make this happen.
The first product Levana will launch is the Levana Leverage Index (LLI) token. These tokens will enable anyone to easily get a leverage position on any asset Levana offers.
Levana is going to gamify their launch using NFTs, which is a very new concept for a launch.
The first phase begins with a meteor shower of Levana Meteors. Levana Meteors are NFTs users can obtain by contributing UST. The UST will then be used by the protocol to buy LUNA for the LUNA2x Pool.
Prism — Derivatives — Founder is Ex JP Morgan / Terraform Labs
PRISM is a revolutionary derivatives protocol that introduces new asset classes in DeFi, allowing users to manage the risks associated with volatile prices and unstable yields in a simple and capital-efficient manner. PRISM achieves this by refracting digital assets into two distinct parts: a yield component and a principal component.
Currently, investors in digital assets have inadequate ways to raise capital or access liquidity with their holdings, with many choosing to pledge these assets as collateral to borrow against their value.
Stories of mass liquidations regularly punctuate newsfeeds given typical crypto market volatility and the typical overcollateralisation requirement for these secured loans.
PRISM innovates on these inefficiencies and enables users to raise liquidity instantaneously by selling their future yield for a period of their choosing, effectively borrowing against future yield. Users no longer face any liquidation risk and can maintain a liquid instrument that can be freely traded or deployed elsewhere in DeFi. The same principles can also be used in yield farms or liquidity pools, where returns can reach thousands of percentage points. PRISM will enable users to guarantee their yield and protect against price movements for a period of their choosing. Conversely, as people fix their interest rates, others will be able to buy the instruments created by PRISM and gain leveraged exposure to an asset’s yield or principal with no risk of liquidation.
PRISM’s mechanisms originate from the founding team’s experience in the $564 trillion interest rate and currency derivatives markets in traditional finance, where participants can guarantee their returns by swapping variable yields into fixed yields or swapping future payments in one currency into another currency of their choice. PRISM will empower DeFi users with these new instruments, and numerous other risk management and investment options in a fully autonomous and permissionless manner…
Talis Protocol — NFT
Besides offering the possibility for artists to sell their art, digital or physical, Talis’ platform supports direct link with Printing Businesses (PB). The list of PB, as well as the list of artists, are curated by the artists and the community. This allows the rise of a Print on Demand decentralised network, self-governed, self-sufficient, and diverse enough to meet the expectations of all those involved: artists, amateurs and customers.
Talis doesn’t aim to profit. It only keeps a negligible fee to maintain its sustainability, the rest of the earnings are split between the artist and the PB.
NFTs also allow the artist to follow the life cycle of their art pieces. That feature makes it possible for them to include a royalty rate during the creation of the NFT, which will automatically be transferred to the artist’s wallet when subsidiary sales occur.
NFTs allow the authentication of an art piece; being able to offer a way of restoring copyright and ownership when a fraud has been committed is long overdue.
It is hard to select out specific protocols for attention, as there are so many being built by great teams, but here are a few more to sharpen your interest…
Orion Money
Orion Money’s vision is to become a cross-chain stablecoin bank providing seamless and frictionless stablecoin saving, lending, and spending. Within the Orion Money stablecoin bank, there are three main products planned: Orion Saver, Orion Yield and Insurance, and Orion Pay.
Pylon
Pylon consists of a suite of savings and payments products in Decentralised Finance (DeFi) that builds on stable yield-bearing protocols such as Terra’s Anchor Protocol, in order to provide services powered by user deposits. Pylon enables sustainable exchanges between long-term value providers and their consumers through customisable deposit contracts and yield redirection.
Nexus
Nexus is an asset management protocol that makes it easy for users to optimise yield with ease. Nexus will offer a variety of products across an array of risk profiles. Nexus will take advantage of credit markets such as Anchor and Mars to maximise yield while managing positions to avoid liquidation.
Apollo DAO
Optimises yield farming strategies to maximise user capital through auto compounding and vaults. Leverages Mirror Protocol to invest in liquidity pools such as MMSFT-UST.
WhiteWhale
For UST to keep its peg, 1$ of UST will always be minted or burned for 1$ of LUNA. This means that when UST trades above or below $1, an arbitrage opportunity exists. Having parties who are willing to perform these arbitrages is essential for the Terra ecosystem. There are also numerous other arbitrage opportunities that exist in the Terra ecosystem that are traditionally only able to be captured by bots.
WhiteWhale is a protocol designed to make these arbitrage opportunities accessible. Users will be able to deposit UST into WhiteWhale and automatically earn yield from arbitrage opportunities. This should further strengthen UST’s peg while creating another yield vehicle for users.
Suberra
Offers a seamless recurring payments solution, for example subscribing to Delphi Digital’s newsletter each month.
The idea behind Suberra is to leverage yield on Anchor to pay for subscriptions. A user would defer the yield on his UST for Suberra to pay for recurrent services.
Now I’ve covered some of the more promising protocols on Terra, let’s discuss the part I find the most exciting: the on/off ramp services being built…
Fiat on-ramps/payment services
For a network to be successful, you need users. Crypto demands a steep learning curve and requires users to jump over several hurdles. This is ultimately a major deterrent for many and is one of the biggest pain points in crypto adoption.
Terra aims to solve this by supporting multiple on-ramps and payments services that integrate directly with the Terra blockchain. This should in turn make Terra one of the most user-friendly blockchains, which should allow it to onboard a significant number of users.
In his interview on Real Vision in July, Do Kwon was adamant that Terra’s success relies on the success of what he called the closed circle. Therefore, the retail products being built are very important for his vision. There are currently three products being built for retails: CHAI, Alice and Kash DeFi, as well as a payment gateway for e-commerce called Kado.
CHAI — Asia
CHAI is the most established and is focused more on the Asian market and is a mobile payment application that bridges the gap between consumers and vendors in Asia. By leveraging the Terra blockchain, vendors and consumers can save over 60% on processing fees as compared to traditional financial institutions.
CHAI does in fact use Terra’s stablecoins, however everything is handled in the back end and the consumer experience resembles a traditional mobile shopping experience. With Terra, CHAI can benefit from blockchain technology and collect transaction fees without having to deal with the conventional cryptocurrency on-ramp barriers…
Kash-DeFi — Europe
Kash is a product of Intellabridge, a blockchain technology company dedicated to bringing decentralised financial solutions to global markets by leveraging blockchain protocols that support stable programmable payments and open financial infrastructure development. Kash is a hybrid product mixing crypto and traditional financial products…
By plugging their back end to Anchor, they are offering easy exposure to Anchor yields for Kash users, providing a very elegant solution with their debit card, very similar to Revolut…
To gain clarity on how they are overcoming any regulation issues, I had a chat with their CEO to really understand how they were able to combine a debit card with crypto.
Cleverly, they have partnered with a German bank (the partnership is not yet public) which has basically white-labelled their card services, so Kash is able to offer this service to their clients. Understandably users are required to fulfil the usual KYC but once completed, can earn high yields on income or deposits from day one.
This project is still in beta, but having tried it, I think the future is bright; I have yet to test the debit card.
Alice Finance — US
Alice is a very similar product to Kash DeFi using Anchor in the back end to provide exposure to high yields. However, they are still in development and have yet to launch.
Alice is a US-based mobile payments app that aims to replicate CHAI’s success. and provide a gateway to decentralised finance. Alice aims to leverage Terra’s ecosystem and traditional financial services to offer DeFi products in a user-friendly experience that mimics mobile banking. This would allow Alice users to earn significantly higher interest rates compared to traditional savings accounts.
Alice will be the first truly organic crypto payment app in the US and would eliminate several hurdles required for users to access yields and products offered in the Terra ecosystem. This will only further drive demand for UST and LUNA.
I spoke to their founder to understand what they were building and was blown away.
Alice finance will have its own debit card like Kash but is also working on an implementation as a payment gateway for shops.
Additionally, once they go live, every US bank account can be plugged into their system providing easy exposure to high yields.
As you can see, the number of revolutionary projects being built on Terra is astonishing, and you can understand how the demand for UST and Luna is going to increase exponentially when these are live. And yet, there is still more: the demand for UST will also come from other chains via interoperability.
Take a look at the ecosystem including other chain protocols…
Interoperability
If there is one thing we know about crypto and its value accrual, it is that exponential network effects play a big part. Interoperability between protocols enables network growth and amplifies network effects rapidly.
Blockchains who were early with ETH-bridges (like AVAX) saw huge growth and fast adoption. People seem to appreciate the value of connecting chains and creating cross-chain opportunities. This is where the opportunity for massive growth may arise for Terra going forwards.
Do Kwon’s vision has always been to make UST and other Terra stablecoins available on every blockchain. His vision is starting to look like a reality…
Wormhole and IBC — and what it means for Terra
Wormhole is a cross-chain protocol that builds bridges between chains allowing transfers between them. Wormhole has recently added Terra to their network of high-value chains (now consisting of Binance, Ethereum, Solana and Terra). This means Terra has now joined three of the top four Layer 1 smart contract platforms. The number of addresses and protocols available to interact with and possibilities for developers, has exploded. As well as providing a gigantic amount of liquidity of course.
The Inter-Blockchain Communication protocol (IBC) is a network of blockchains built around the Cosmos SDK. Like Wormhole it enables transfers and communication between other IBC-compatible chains like crypto.com, Cosmos, Osmosis, etc. This unleashes even more power of UST and Luna. 20% APY for everyone.
With only eight active protocols, Terra is the fourth largest network by TVL…
The combining network effect of 160 protocols launching on Terra with all the cross-chain integrations, represents a real opportunity. Unfortunately, the Terra ecosystem also has risks and is not yet 100% safe.
The risks
Not having UST backed by actual USD obviously brings risk to the system. The concept of crypto and decentralisation is by nature not robust, it rather aims toward being anti-fragile. The risk that might seem most obvious is a mass liquidation or bank-run scenario, which we — kind of — saw in the crash of May 2021.
Regulations
Mirror is under SEC scrutiny as Do Kwon was served by the SEC at the Messari conference in New York a few weeks ago to discuss the protocol. I think it is very easy to understand how synthetics can be very challenging from a legal point of view. But in this case the protocol is now decentralised, so I am not sure the SEC will be able to do much about it.
Do Kwon and his legal team decided to sue the SEC in return, which is a first in crypto, and this is definitely a story to follow as it may well set some precedents.
The decentralised aspect of core protocols developed on Terra must be a real headache for the SEC.
Mass liquidation
Back in May 2021, we saw a deleveraging of the entire crypto ecosystem as regulatory risks piled up and the market had its way dealing with over-leveraged players (as it often does). The overall sentiment went risk-off and the price of Luna saw a -80% drawdown from ATH. Because borrowers on Anchor at the time only were able to have Luna as collateral, a liquidation cascade happened and the market cap of Luna (based on circulating supply) at one point went below the amount of outstanding UST. This caused further panic and UST sell pressure, causing further minting and dilution of Luna: a vicious spiral that caused UST to trade at roughly 0.93$ for a period of time. This mechanism makes Luna extremely price-reflexive.
One of the issues with this mechanism is that the burn/mint “machine” that holds the peg is subject to a cap regarding the spread. This cap is in place to prevent another risk, one of front-running. As Terra price feeds are derived from validator oracles, there is a small delay between prices reported on-chain and real-time. Malicious attacks are therefore possible if there is a large difference in liquidity on-chain vs off-chain. A front-running attack could theoretically be done by market buying on an oracle-exchange with low liquidity pushing the price higher. The price would then be reported on-chain and the attacker could swap for a false “true price”, extracting value from the network. The cap is to prevent this kind of attack.
Since the crash, the capacity of the network and swap spreads has increased greatly allowing more than 17x the absorption by the swap mechanism. The system did not completely crash and, by its anti-fragile nature, grew stronger. As liquidity grows, it becomes more robust.
Mission to keep the peg
As you can clearly see, the biggest risks for Terra are all about the peg. Luna is extremely price-reflexive to the peg, and developers have skin in the game. There is a lot of brain power going into solving these issues; it is quite clear to everyone in the community that the mission of keeping the peg is the most important.
I recommend watching Do Kwon’s interview on Real Vision:
I have no doubt that new fast-growing chains will outperform Ethereum and/or Bitcoin in this run, and I strongly recommend you also investigate Avalanche, Polkadot, Near, Polygon, Fantom and Solana. And I am also sure that new opportunities will emerge.